Annuities: The Good, the Bad, and the Ugly

In 1966 Clint Eastwood boosted his film career by staring in the western, The Good, The Bad and the Ugly. This western film title can be used to describe annuity investments. Annuities can be a “good” investment by helping serve the purchasers’ financial goals, but only if matched with the right person under the right circumstances. If matched with the wrong person under the wrong circumstances the annuity becomes “bad” or even “ugly”.

A “good” annuity depends on a variety of factors including a client’s age, income, net worth, the length of payment period and type of annuity. If these factors are inappropriately matched or the annuity has hidden and hefty commissions, then they are “bad and ugly” annuities.

What is an annuity? An annuity is an asset swap. You trade your savings for a stream of income. Some annuities called immediate annuities begin immediate pay back as monthly installments. These installments can be as long as a lifetime or as short as 1 year. These annuities have a single premium paid when the annuity is purchased.

A too often touted and too often mistakenly purchased is a deferred annuity. A deferred annuity invests your premium for the long term. These annuities are subject, often in the annuities’ first 7-10 years, to an early withdrawal penalty.

When is a deferred annuity “good”? If you are in the work force, earning a high salary and further wish to enhance your retirement assets, a deferred annuity either fixed or variable may be a financial product for you. The good about these annuities is the growth is income tax free while you remain in the work force and you do not make withdrawals. The goal when purchasing a deferred annuity is to avoid a tax in the growth while you are in a high wage earning tax bracket. Then when retired you make withdrawals at a hopefully lower tax rate than when you were making big wages.

In certain circumstance a deferred annuity is “bad and ugly” such as when purchased by a retiree receiving limited retirement income. By buying a deferred annuity the limited income retiree loses the opportunity to access his savings without penalty. Also the deferred tax on the growth of the annuity is of little benefit as the limited income retiree is already in a low or 0% tax bracket.

For retired folk, living on limited income, the single premium immediate annuity is neither “bad nor ugly” but may be a sleeping beauty. Here are a few examples of when an immediate annuity can do good:

  • Retirees living on social security and a very modest pension and may need an additional income to cover regular financial short falls. By using a portion of their savings to purchase a single premium immediate annuity, the immediate annuity will give their monthly income a boost.
  • A retired person with modest income transitioning from home ownership to a retirement village apartment may be wise to purchase a single premium immediate annuity (SPIA) with their home’s sales proceeds. The immediate annuity would then provide added monthly income to help the retiree cover rental costs.
  • Another beneficial way to use a single premium immediate annuity is in nursing home planning. The spouse living in the community can use the immediate annuity to protect assets from nursing home care. The process of using an immediate annuity to protect assets from nursing home costs is technical and requires the assistance of an attorney knowledge in nursing home planning.

When considering an annuity purchase give yourself time to think and then question:

  • Can the annuity be passed along to a beneficiary? And if so under what circumstances?
  • Will my purchasing an annuity deplete my available resources? Will I still have enough cash assets to meet emergencies, deserved vacations, home renovations and repairs, school taxes or a new car?
  • How risky are the annuity’s underlying investments, how high is its sales commission, management fees, and most importantly its withdrawal fees?

To find the right match in annuities for your family, it is important to understand one’s needs by reflecting on one’s future and current financial and physical condition. Not to compare, not to truly understand, and not to ask good questions is to end up with a “bad” or truly “ugly” annuity.

Robert H. Lugg, a Lock Haven Attorney and “A Resource for the Long-term Care Community” may be contacted at www.lugglaw.com or 570-748-2481.